China is putting more and more faith in its banks to lend more money for mortgages and help its sinking housing market. But there’s a problem: lenders are stuck with mortgages from the real estate boom that could not be paid back.

How does house sales work in China?

In the last ten years, about 80% of new homes sold in the country were half-built homes that builders promised to finish in one to three years. Buyers usually put down 30% of the property’s purchase price as a down payment, borrowed the other 70%, and started making mortgage payments right away.

The money from down payments and mortgages went into escrow accounts, which were supposed to pay for the construction of the buildings. Local governments will give presale permits to projects that had only been built 25% of the way they were supposed to be.

Since the mortgages weren’t backed by finished homes at first, Chinese developers gave banks guarantees that they would pay the loan’s interest and principal if a borrower stopped making payments while the house was still being built. In their regulatory filings, many real estate companies said that this was common practice in the industry and that they were unlikely to have any real financial obligations because of it.

When the homes were finished and the buyers took ownership, the guarantees stopped, and the mortgages were then backed by the finished homes.

Rosealea Yao is a senior analyst at Gavekal Dragonomics in Beijing. She said that this set-up was fine for a long time because real estate was a successful business. She said that banks were happy to help with the deals by giving homebuyers loans and giving money to developers in advance.

However, China’s escrow account rules were not very strict, so Chinese developers could get their money out before buildings were finished and use it for other things.

Edward Chan is a director and property analyst at S&P. He said that a presale system developed without a set of comprehensive regulations. And that was the problem. 

Chinese banks face a mortgage safety crisis as developers slide into distress

Regulatory filings show that over the past few years, Chinese property developers wrote at least $300 billion in mortgage guarantees for apartments that were only partly built but that they had already been sold.

What was once seen as a win-win situation is now a burden on Chinese banks. Dozens of real estate companies are in financial trouble, which makes it hard to know if they will be able to back their mortgages. Many people who want to buy a home no longer want to buy one that isn’t finished, which lowers the demand for loans.

According to the Wall Street Journal, this year, the request for mortgages in China dropped sharply. From January to July, Chinese households borrowed the equivalent of $249 billion in medium- and long-term loans, which is 55% less than the same time last year. This information comes from official data on Wind. Most of these loans are used to pay for homes.

The sales of new homes by China’s top 100 builders have gone down for 14 months in a row. China Real Estate Information Corp., an industry data provider, says that they fell 47% in the first eight months of this year.

Also, the number of transactions for new and used houses in Beijing, Shanghai, Guangzhou, and Shenzhen dropped.

This is despite the fact that in August, Chinese banks cut the benchmark lending rate for mortgages to make it cheaper for people to get loans to buy homes. This is the second time this year the five-year loan prime rate was cut.

Many property developers are having trouble getting money and don’t have enough to finish their projects. Over the summer, angry buyers in more than 300 cities across China threatened to stop paying their mortgages if their apartments weren’t finished and delivered on time.

There is a real chance that some housing projects won’t be finished because the downturn in the housing market has left some developers with very little money. According to S&P Global Ratings report, in the worst case, about half of the projects of troubled developers could be stopped or put on hold, and 6.4% of China’s mortgages, or about $348 billion in loans, could be at risk of default.

Mainland China Business News reported on September 6 that the “personal housing loans” of the six largest state-owned banks added up to 26.9 trillion yuan in the first half of this year, which is only a small increase from the beginning of the period. During the same time last year, the increase was as much as 1.3 trillion yuan. This year’s rise is only about 1/3 of what it was during the same time last year. This is a new low.

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